Is Daihatsu Diesel Mfg (TSE:6023) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Daihatsu Diesel Mfg. Co., Ltd. (TSE:6023) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Daihatsu Diesel Mfg

What Is Daihatsu Diesel Mfg's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Daihatsu Diesel Mfg had debt of JP¥14.2b, up from JP¥13.0b in one year. However, its balance sheet shows it holds JP¥32.7b in cash, so it actually has JP¥18.5b net cash.

How Healthy Is Daihatsu Diesel Mfg's Balance Sheet?

We can see from the most recent balance sheet that Daihatsu Diesel Mfg had liabilities of JP¥29.9b falling due within a year, and liabilities of JP¥20.4b due beyond that. On the other hand, it had cash of JP¥32.7b and JP¥18.2b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

Having regard to Daihatsu Diesel Mfg's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the JP¥50.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Daihatsu Diesel Mfg boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Daihatsu Diesel Mfg has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Daihatsu Diesel Mfg's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Daihatsu Diesel Mfg may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Daihatsu Diesel Mfg recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Daihatsu Diesel Mfg has net cash of JP¥18.5b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 74% over the last year. So is Daihatsu Diesel Mfg's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Daihatsu Diesel Mfg .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.